Tag Archives: Supply and Demand

Inefficiency…the real beneficiary of trade protection

      While politicians—particularly Donald Trump—are busy promoting how protectionist trade measures will help our economy, the reality is that all of us lose when we turn our backs on free trade. Well, not all of us. There is one group that benefits…the inefficient (not to mention those politicians). And they win at the expense of everyone else.

    Inefficiency is the primary beneficiary of trade protection. [Inefficiency is defined in two ways according to dictionary.com: 1. not efficient; unable to effect or achieve the desired result with reasonable economy of means; and 2. lacking in ability, incompetent.] However, so many of us get caught up in nationalistic sentiment to realize what is abundantly clear. The popular mantras include Americans “losing” their jobs to sweat shops and foreigners; companies “outsourcing” phone centers; or auto manufacturers shipping those poor union member’s jobs south of the border. All bunk. Let me give you an example that might help clear things up because the emotion has been removed.

     Let’s say in your town you have an intersection with two gas stations. At the QuickUp—yeah, I made that up all by myself—the employees are friendly, the facilities clean, the beer extra cold, and the pumps always give you a receipt instead of having to “see cashier” (I hate that…if I wanted to “see cashier” I would not have swiped my card!). Across the way, at the Sucks2B-N the store lives up to its namesake; the facility is filthy, the bathrooms are always closed, and the employees view you as an inconvenience to their normal texting routine.

      Now, not surprisingly, the QuickUp sells more gas and has better profits than the Sucks2B-N which is clearly unfair…right? So, to keep Joe the crackhead, Rebecca the part time meth-cooker, and Jim (the owner with a gambling problem) from losing their jobs, the local government institutes some “trade protection.” Basically, if you want to stop by the QuickUp, you have to pay a tax of 5%; that way we do not lose valuable jobs in the community, because if the Sucks2B-N closes, those three people will be unemployed, right?   After 6 months people are still going to the QuickUp—because that’s how bad the Sucks2B-N sucks to be in—prompting local government to increase it to 35% to ensure success.

     As expected, people are largely unable to afford to go to the QuickUp and a significant portion shifts to the cheaper Sucks2B-N.   Joe, Rebecca, and Jim are all better off now and have secure jobs. While the QuickUp, with a staff previously at 20, now has only 8 employees left (that means we are down 11, by the way). But, on the bright side, we get 4 jobs “back” with the addition of new employees which have been hired at the Sucks2B-N (it is easier to provide crappy service as it turns out…who knew).

      Here is the bonus though. In economics, it has been empirically proven that in the light of high tariffs (trade protection) the domestic producers raise their pricing to be more in line with foreign producers’ new pricing which includes the tax. Because Sucks2B-N follows predictably with what economics has long known, the people of your town can afford less ice cream for their families and two more jobs are lost at the parlor (11-4+2=9 jobs lost to save 3…hmmm). And that example could potentially apply to any type of good. In fact, other employers have to buy fuel at the more expensive price therefore they have less money for raises and increased benefits. In the light of reduced sales in other market segments, the local government takes in less tax revenue. In short, everybody in town has essentially paid a tax—in the form of higher prices and reduced future wages—to ensure that Joe, Rebecca, and Jim stay employed…still feeling warm and tingly inside? The “Inefficient 3” (catchy, I know) has been relieved of the consequences of inefficiently operating a gas station and you have received the bill. Both trade protection and the gas station example are, for all intents and purposes, wealth redistribution; a very costly form of redistribution at that. This kind of redistribution has much higher transaction costs than simple welfare leading to an increased magnitude in the future through the compounding effect.

       We must always keep in mind that if production of a good goes elsewhere, there is a reason and we, the consumers, have made that choice. Consumers make choices based on cost and quality that drives producers (i.e. businesses and corporations) to change their production methods and sources. And this is okay. Does this mean some people lose their jobs…certainly; but people lose their jobs all the time for inefficiency, we only seem to mind when it is to someone that is not an American citizen. Additionally, the amount of future production (read as consumption and the ability to have “stuff”) goes down making us all relatively poorer to subsidize—or benefit—a few. In fact, anyone that truly favors trade protection should thank the next fast food employee that screws up their food, or the next server that brings the appetizer after the entrée. Or the next car salesman that sells them a lemon…so on and so on. At least be consistent and support inefficiency directly in all its forms.

The nature of black markets: why making commodities illegal is ineffective.

I think it is important to characterize the commodity in very a generalized manner—at least for now—therefore we will refer to our commodity in question as a widget. Now, it is of no consequence what a widget is because, when analyzing the effects of a black market, the only relevant factor is that widgets were made illegal by lawmakers. It is important to begin with a basic definition of a black market:

“A black market or underground economy is the market in which goods or services are traded illegally. The key distinction of a black market trade is that the transaction itself is illegal. The goods or services may or may not themselves be illegal to own, or to trade through other, legal channels.”

It is important to note that the definition also identifies that the goods (in our example widgets) need not be illegal to own. This refers to situations where taxation or regulations are used to limit, control, or inhibit the trade of a good or service (i.e. high cigarette taxes). However valid this discussion is, it will not be the focus of this conversation as we are assuming our commodity has been made illegal for the sake of simplicity.

Black markets develop because making a product illegal does not cause people to stop using it; instead, it merely marginalizes consumption, the production, and the distribution to those who are willing to accept and operate under greater degrees of risk. I know this may sound a little confusing which is why I created a graphic that illustrates the levels of acceptable risk for different groups of society:

Risk flow chart

In this graphic we can observe that the lower two segments (5 & 6) are those people who enjoy or are comfortable with greater risk levels; next (segments 3&4) we can observe the greatest amount of people as the average level of risk takers which would be generally averse to great risk, but partaking in some low/moderate risk; finally, in our upper two segments (1 & 2) we can see a portion of the population who range from mostly risk averse to almost exclusively averse to risk. This understanding of risk tolerance is important in the realization that making commodities illegal only serves to focus use and production on the risk loving segments which are most likely to partake in other risky behaviors (e.g. crime, violence, etc.) regardless of their use of a certain commodity. This reality is why the argument of illegality for the purpose of public safety is largely invalid.

Let us return to our concept of widgets again. If widgets are made illegal then we have some serious problems: 1) people are still demanding this product (although demand is now almost exclusively coming from groups 5&6 and a small part of group 4) so new producers will enter the market to meet this demand and receive the greater profits now offered by an illegal trade operating at monopoly pricing. 2) By compressing consumption to the risk loving segments we create a self-fulfilling prophesy – that the people using the widget will also be breaking other laws [don’t believe me?…look at why prohibition did not work for alcohol].

We can see a new and growing market segment dominated by those who are more predisposed to risky (read: criminal) behavior. Also, we have reduced competition in the production of widgets which would generally (particularly in a highly criminalized black market) lead to the production of “crappier” products at higher prices. Therefore, the risk factors of our widgets become even greater due to the lower quality. Additionally, in this market with limited competition, lower quality requirements, and huge profit margins we will observe more criminal (mob-like) activities in the production and distribution of our widget. In essence, criminal producers compete with force instead of with price or quality (or both) to gain customers; this has many negative effects on the communities in which these suppliers operate.

We are also presented with a consumption level distortion. The new consumer group—which is also isolated to higher risk tolerances—engages in the same activities they would have likely done anyway; however, now our widgets are given the credit (blame) for these activities. This creates somewhat of a paradox in that the results of prohibition become the best argument for prohibition because the correlation between widget use and other risky/criminal behavior increases due to us arbitrarily slicing segments 1, 2, 3, and most of 4 off of the consumer base. We have not eliminated any undesirable by-products of consuming widgets; we have merely magnified the (rudimentary) perception of the widgets’ effect on producing these negative by-products.

Why is this important? First, there are little to no positive effects of making products illegal beyond people making themselves feel better that they may have coerced others into not engaging in an activity this other person condemns [think Michael Bloomberg and soft drink sizes]. Second, by isolating supply to risk loving individuals we fuel illegitimate activities and isolate supply into the hands of people willing to exercise the most risk. Not only have we criminalized users, we have laid the foundation to launch a whole new and highly profitable enterprise that relies on criminal activity and violence as the primary means to restricting market entry. This incorporation excludes traditional competitive means (product differentiation and price) in favor of force, violence, intimidation, and a new criminal recruitment system resulting in social problems in these communities as well as losses in property values, tax revenues, and legitimate employment opportunities.

Gun rights advocates make this argument quite accurately and succinctly when they state that: “making guns illegal would only keep them out of the hands of the law abiding population who do not commit crimes anyhow.” This is a very astute observation. Unfortunately, this same group often fails to realize that the same is true for our widget example, or drugs, or prostitution, and was found empirically to be true with alcohol. Making any of those things illegal did not eliminate the use of them; it merely marginalized use and created a criminal enterprise where one did not previously exist. Does prohibition result in decreased use?…only a little because, if the product is inherently risky, a vast majority of the population will avoid it anyway. Does prohibition make society safer? No, in fact the evidence would indicate the opposite.

So, why does our society struggle with this idea? Because liberty is scary to so many people! Of course, liberty—like so many other things—is really only a good idea for ourselves, not for others. The false premise that one group of people has the responsibility or authority to try and save others is preposterous and, I would argue, excludes the people who hold that idea from having any real profound understanding of the concept of Natural Rights or the ideas that our founders held so dear in creating this greatest of countries. The land of the free has become the land of the busybodies, intent on utilizing their votes to gain access to the force that government wields to make individuals “mind” them. I do not wish to have a nanny state economically nor do I wish to have one for individual choices. Incidentally, one thing everyone should keep in mind, you do not get one of those without the other.

Why the government cannot fix healthcare.

     There is a significant obstacle facing government in any attempt at “fixing” the costs of medical care:  reality.  Yes, reality, that often loathed principle of life for which we cannot escape yet seem to try tirelessly to ignore.  Obamacare seeks to repair healthcare through government subsidy, an increase in the pool of insured (which may lower the cost of health insurance, but not the cost of medical care), and coercion of providers to lessen their own fees.  However, it apparently fundamentally ignores the two primary factors that actually dictate prices in a market.

        I am writing of supply and demand, which represents Adam Smith’s principle of the “invisible hand” that guides the market and allocates goods in a world of unlimited wants and limited resources; in other words, that is how scarcity is dealt with.  Rationing is an undeniable fact of life and is the basis for all prices.  Government’s attempt to control the health market without addressing scarcity of supply and an overabundance of demand is doomed to failure from the word go.  Additionally, transferring the costs of health care through subsidy does not make it any cheaper, it only transfers those costs from direct medical payments to increased tax liability or to increased deficit spending; and amounts to more of a Chris Angel illusion than a solution.

        What about the fines for those who do not purchase healthcare you might ask?  Well, to state it simply, they are largely irrelevant.  The most recent Congressional Budget Office (CBO) projections show that approximately six million people (and counting) will incur fines of approximately $1500 each (FYI:  that could be you), amounting to somewhere between $8 and $9 billion in revenues to the government.  There are two main problems with using the fines as a way to offset increasing prices.  First, government subsidies for insurance will undoubtedly exceed the fines.  Second, people who did not purchase insurance previously so they could save money will likely pay the fine as opposed to obtaining insurance (which would be significantly more expensive) and still will not pay their bills when they go to the hospital; thus maintaining the “free rider” status quo (in Pelosi parlance).

        Another important aspect to consider is that, as fines to employers are cheaper overall than actually carrying insurance, there is likely to be an increase in the number of uninsured, which previously were covered at work and thus more people receiving subsidies for insurance, or incurring fines for that matter (once again, this could be you).  This does not even factor in the likelihood that those employers who are on or near the threshold requiring them to provide insurance or pay the fine, which would result in a loss in income for the business owner (and thus a decrease in “revenues” to the federal government), will cut back employees (unemployment), trim some back to part-time (under-employment), or be hesitant of growing their business (an even more stagnant job market).

        All of these negatives…and pricing has not even been addressed.  Ironically, the only potential part of Obamacare that might affect pricing, the Independent Payment Advisory Board (IPAB) (or, death panels in Palin parlance), is denied to be a rationing board.  If it is a rationing panel, we have a bureaucratically operated health lottery for old people (and, at some point, probably poor people through Medicaid); if it is not, the disparity between supply and demand will remain, or worsen, and costs will not change (downward anyway)…or will they?  It is actually irrelevant if Democrats are right and it is not a rationing panel; if it is a rationing panel prices will be curbed by decreased access (i.e.-less people getting care, which I thought they were trying to remedy…?).  However, pricing will be affected if they are absolutely correct and it is not a rationing panel, but a direct price controlling board:  overall costs will likely stay the same at best.  Now, if a price ceiling is imposed, that will restrict the number of providers wishing to enter the market (hospitals, doctors, nurses, etc.) and reduce the number of manufacturers wishing to develop and produce goods for health care (medical equipment, drugs, etc.).  We can remedy this, though, so all is not lost; let us reduce the obstacles to entry into those markets making it cheaper and easier to get “qualified” providers and manufacturers.  Do not begin rejoicing yet, that means the guy who was previously going to go into golf course management (with a 17 on his ACT) can now, for just a few dollars and years more, become a doctor.  Scared yet?  By this action we have reduced pricing by reducing quality (and probably increasing mortality) This must not be the case though as we have been assured quality will not suffer, so that must not be the plan either, right?

        There are three ways you can actually reduce the cost (and thus pricing) in healthcare:  1) increase supply through a reduction in obstacles to entry into the market (accomplished through reduced admission requirements into med school, increasing maximum entry quotas into med school, and establishing more med schools, etc. etc.); 2) we can reduce demand by letting more people die without care (Kevorkian care, anyone?  I do not think any of us like the sound of that…); 3) freeze the development of new technology in medical care (technology gets cheaper over time, particularly when you remove the need to mark-up to cover future research and development).  In fact, if we would have frozen medical technology one hundred years ago, costs would be next to nothing now; of course, bleeding would still be the primary cure for most ills.  On the “bright side” this would have maintained the “promised” costs of Social Security by freezing mortality for people to a point in which almost nobody would have lived long enough to collect it.

        Another fallacy proposed by both parties is that reducing fraud in Medicare will reduce the overall cost; however, this will only reduce the cost to government as pricing will have to increase to individuals to cover lost fraudulent revenues to providers.  This amounts to another cost sleight of hand, the alternate equivalent to that of subsidizing insurance.  Ultimately, if we are all dedicated to reducing the cost of healthcare, which would you choose?  Rationing does exist in the market, and that will not be eliminated through the government control of it unless quality or technology is influenced to address pricing.  Collectively, we must decide whether we will pay more for more — or wish to pay less for less; that is an undeniable fact of life in any market.  Whether you are a Republican or Democrat is irrelevant because neither is being honest about the problem because the voting public values fantasy over facts; ultimately, there is no solution that maintains technology and quality of service, increases access, and reduces costs.

        But, before we tinker with the most technologically advanced healthcare system in the world, perhaps we should try out these theories on the bubble gum market which will at least not result in the death of people so that politicians may try to “muddle through” to a solution which is patently unrealistic.  If the new “Obamagum” plan worked as they say Obamacare will, gum prices will go down (as will the overall cost of gum nationally), more people will be chewing gum, and there will be vastly better increases in gum technology.  If they are wrong, gum will not increase in quantity (relative to the increase in demand), variety of flavors and manufacturers will decrease, and the overall cost of gum and the gum market will increase.  Sounds like a safer experiment to me.  Please, let us refrain from killing people to just to prove that central planning and socialism still does not work!  Fair enough?